Startup studios are a relatively new model in investing into early stage startups. Startup studios invest into internally generated startups as compared to angels and seed stage VCs who invest into startups founded by other entrepreneurs.
2 main models are currently present in the early stage investing space, the accelerator model and what we can refer to as the seed investor model. The 2 models can be differentiated based on 3 dimensions, a) investment amount, b) equity position and c) portfolio management.
Accelerators invest a smaller amount ($100k-150k) for about 6-7% in a larger number of companies, while seed investors invest a larger amount ($250-500k) and hold a larger equity position in a smaller number of companies.
The accelerator model adopts the philosophy that the design of a portfolio is inherently difficult and is best managed via the improvement of the probability of success, which is achieved by investing into many companies. The large number of companies make active management difficult. ‘Managing’ the companies is dealt with via education through a program that often ends in a demo day.
A seed investor puts in greater effort into the portfolio design process, carrying out detailed due diligence in validating companies. The seed investor also typically spends more time working with the startup company.
Startup studios can be thought of as a nearly emerging third model for investing into startups. Startup studios are at one end of the spectrum with the greatest equity position and also the greatest effort in managing the startup. While this could differ with different startup studios, in our experience, the initial funding needed is similar to what a seed investor would invest. Since the portfolio management is significant, startup studios tend to be started by entrepreneurs rather than fund managers.
The benefits of a startup studio as an early stage startup investment vehicle are clear. One of the main benefits is the high ownership. For a similar investment as a seed investor, the studio owns a larger share of the company as compared to a seed investor. Another advantage is that the studio is the founder and the investor and hence, does not suffer from information asymmetry.
With the high ownership, a studio can potentially reap a high return if a portfolio company is successful. However, startup studios face a number of challenges including the following:
- Difficulty in generation of ideas comparable to the quality and quantity of the deal flow of a seed investor.
- Difficulty in evaluation of ideas rigorously at the early stages. A company looking to raise funds from an external investor is usually further along. The opportunity would have been defined by the entrepreneur. The investor has decent information to make an investment decision. A startup studio on the other hand has to evaluate if they want to pursue an idea with very little information at the early stages.
- High cost of idea evaluation. Evaluating an idea requires studying the opportunity in terms of the market, technology, industry dynamics, trends etc. This is a time consuming task. Further, testing the feasibility of a new concept can get expensive, especially if it requires developing physical prototypes and carrying out multiple experiments.
- Difficulty in forming the teams for each idea. When the studio has a great idea, evaluated it and decided to pursue it, it faces the challenge of building the team to take the idea to the next stage.
At SIC, we are continually exploring and experimenting with ways of being effective in generating ideas and efficient in evaluating ideas and building teams. We look to share our learnings in future posts.